Buying a home when you have bad credit makes it harder to realize your dream of ownership. While it’s challenging, it’s not impossible to get a mortgage with less than stellar credit. There are also steps you can take that can improve your credit that will make you more attractive to a lender.
What Is Considered Bad Credit?
When people use the term, “bad credit”, it’s typically referring to their credit score. This is a calculation that measures how risky you are as a borrower. Your financial history includes your track record of making on-time payments on credit cards, loans, and other financial obligations. Credit scores are used by lenders to help them decide whether to take you on as a borrower.
There are different credit scores that lenders may use, but one of the most popular is the FICO® credit score. It uses a scale between 300 and 850, with the higher the number the better. Typically if you a 680+ credit score, you will be able to secure a mortgage loan. Here’s a look at the FICO® credit score ranges:
801+ and more = Exceptional credit
741-800 = Very good credit
671-740 = Good credit
580-670 = Fair credit
Below 580 = Poor credit
Don’t be too discouraged though, you can still get a mortgage if your credits scores are lower, you will more than likely be subjected to a less than prime interest rate. There are other factors that a lender will look at besides your credit score. Your income and down payment are two examples; requirement vary by lender.
How to Check your Credit Score
To monitor and check your credit score, you have a lot of resources available to you. Many credit card companies will provide you with access to your credit score by logging into their website or mobile app. The three credit bureau reporting agencies, Experian, TransUnion, and Equifax all offer credit score access.
Home Loan Options for Buyers with low Credit Scores
There are a few types of loans that you can potentially get approved for with a low credit score. Here are some of the options for low credit borrowers below:
The Federal Housing Administration (FHA) loan is backed by this government entity. This loan program was intended to help low and moderate-income borrowers who aren’t able to buy homes because of having a bad credit score. As long as you have at least a credit score of 580, you can qualify for an FHA loan. You must also be able to make a down payment of at least 3.5%.
Now there is a tradeoff for the lower credit score and down payment requirements. All FHA borrowers are required to pay an upfront mortgage insurance premium (UPMIP). The current UPMIP is 1.75%. On a $300,000 mortgage loan, that’s an additional $5,250. Also, there’s annual mortgage insurance that’s usually around 0.85% per year.
FHA VA Loan
If you are an active-duty military member, veteran, or another qualifying group, you could be eligible for a VA loan. Backed by the U.S. Department of Veterans Affairs, you can get approved with a credit score below 620. There’s also no down payment or mortgage insurance premium. You must meet the VA’s eligibility requirements to qualify for a VA loan and get a Certificate of Eligibility.
The U.S. Department of Agriculture is the government entity that backs USDA loans. To get this loan, you must be buying a house in a qualifying rural area. Your credit score must be at least 640 in most cases to qualify. These loans are geared towards families who demonstrate economic need,. Your gross adjusted income must not be more than 115% of the median income in the area.
What can I do to Improve my Credit?
The best option for borrowers with bad credit is often to work on improving their credit score. You will have more loan options, lower-income, and down payment requirements. A better credit score can help you get a lower interest rate which can save thousands of dollars over the life of the loan.
First let’s understand the factors that affect your credit score, using FICO®:
- Payment history (35%) – This is the biggest factor that determines your credit score. It’s your track record of paying your bills on time.
- Credit utilization (30%) – This is the comparison between the amount of credit you’re using to the amount of credit you have available. It’s best to keep your credit usage under 30% to maintain or improve your credit score.
- Age of credit history (15%) – Also called the Average Age of Accounts, this is based on the age of the oldest credit account, new credit accounts, and average ages of all accounts found on your credit report.
- Credit mix (10%) – If you have seen your credit report, you have probably noticed different types of credit are being reported. Credit cards are reported as revolving credit, while personal loans and car loans are called installment loans. Having a mix of these types of credit is good.
- New credit (10%) – Typically, a new credit account is considered one that’s been opened for less than 6 months. Opening new accounts lower your credit score and affect your age of credit history. It’s best to open new accounts sparingly.
Review your Credit Report
Lenders use your credit report to look at your financial history including bankruptcies and collections. It’s also used to calculate your credit score. You can get a free copy year of your credit report from each of the credit bureau agencies. Use your copy to review your history and check for errors. If you find a mistake, immediately report it to the credit bureau.
Pay all your Bills on Time
The impact of even one missed payment is too great. Sign up for auto-pay on all your bills so even if you forget, you’re covered. Budget your money so that you can pay your bills when they’re due.
Pay down your Credit Card
Make a plan to pay off your credit cards faster. This will lower your credit utilization and improve your credit score.
Don’t open new or close old Accounts
Try not to open too many credit accounts in a short timeframe. It makes lenders nervous because it looks to them like you have a financial issue. Even if your first credit card from over a decade ago has been sitting in a drawer, keep the account open. Closing it will lower your credit score. We recommend using the card to purchase a small purchase, like a tank of gas, and immediately paying the card in full.